Social Security Automatic Adjustments
The July 2017 edition of Commentary described the system of parametric adjustments to the United States Social Security system, indicating how certain features of the benefit structure are subject to periodic adjustments that are typically tied to inflation, as measured by changes to consumer prices or national wage levels. These adjustments include an annual cost-of-living adjustment that is applied to benefits in course of payment. Other adjustments to the benefit structure include the basic components of the formula for determining the Primary Insurance Amount and individual workers’ earnings history, based on changes in national wage levels. While the benefit structure has several dynamic features, the financing structure is limited to periodic adjustments to the maximum amount of taxable earnings on which the payroll tax is levied. However, the payroll tax rate that is the main source of financing for Social Security is static, not dynamic; the current rate is 6.20 percent of taxable earnings, payable by employees and employers. This rate was set in 1990 and has remained unchanged since then. The concept of financing a dynamic Social Security system with a fixed payroll tax rate is not viable in the long run, mainly because the escalation of costs beyond the standard projection period of seventy-five years, due to demographic and economic changes over time, is not accounted for. The use of a fixed payroll tax rate structure has had the effect of gradually eroding the solvency and sustainability of the system, resulting in projected long-term deficits, putting at risk the ability of the system to meet scheduled benefit payments. Logically, if all scheduled benefits are to be met in full, the financing system should be dynamic so as to maintain continuous actuarial balance between projected income and outgo. This may be accomplished by introducing a dynamic payroll tax structure that would feature small incremental annual changes to the basic fixed tax rate. It is somewhat paradoxical that the United States Congress would enact a Social Security law that establishes a specific regimen of scheduled benefits, but does not contemporaneously authorize the necessary financial resources to meet the obligation for the actuarial value of these scheduled benefits. As a result, the Social Security system is subject to political pressures to reduce expected scheduled benefits to a level consistent with the available authorized financial resources, under the guise of reform or modernization. Whilst some observers regard this situation as an appropriate and balanced means of maintaining the long-term solvency and sustainability of the system, others take the view that this strategy is effectively conflating two entirely separate issues, namely the financial soundness of the system, and the suitability of the system’s benefit structure for modern society in terms of adequacy and equity.
The American Academy of Actuaries has recently published a revised edition of its Issue Brief on Social Security Automatic Adjustments. This comprehensive issue brief presents an analysis of Social Security’s long-range financial situation together with a series of options for potential new automatic adjustment features. These include adjustments to taxes, specifically an increase in the payroll tax rate and increases in the taxability of benefits. The Academy’s issue brief also considers adjustments to the normal retirement age as a means of reducing scheduled benefits and ameliorating the effects of erosion in the long-term actuarial balance between projected income and outgo. While it is acknowledged that, from an actuarial perspective, adjusting the retirement age merits consideration, the concept has been widely criticized by social policy experts because of its anticipated adverse social and economic consequences. An important aspect of any automatic adjustment system is the actual trigger mechanism that activates the adjustment; the Academy’s issue brief states that defining an appropriate trigger mechanism for automatic adjustments is as important as defining the adjustments themselves. While the conventional measure of the financial condition of the Social Security system is based on the projected deficit over a future seventy-five year period, the Academy’s issue brief notes that “Given the great uncertainty regarding how the economy and society will evolve over the 75-year period, some will argue that basing automatic adjustments on actuarial balance as measured in the Trustees Report is inappropriate. Others may argue that gradual adjustments would not be disruptive.”
The July 2017 edition of Commentary had addressed this specific point and concluded that the desired result could be achieved by introducing a dynamic payroll tax structure that would feature small incremental annual changes to the payroll tax rate that are remarkably small and affordable. This edition also recommended a graduated scale of payroll tax rates as representing good social and economic policy and concluded that the combination of graduated payroll tax rates with a modest incremental annual adjustment system could be readily managed to ensure the continuing solvency and sustainability of the US Social Security system.